A Great Global Stock With a Free Kicker

Legendary investors are made by their ability to anticipate the trends that will shape markets well before those trends are widely seen or priced into the market. Super-investor Warren Buffett closed out much of his derivatives exposure from subsidiary General Re by 2005, well before derivatives hit the wall from 2007 to 2009, which helped him avoid the meltdown.

Now a growing chorus, including the voices of the Obama administration and prominent economists such as Fed Chairman Ben Bernanke, is calling for a change that will cause a massive shift in international trade. This means agile investors have an opportunity to play this change before it's fully reflected in share prices.

Excellent exchangeThis massive shift concerns China's exchange rate, which many analysts view as simply too low and as destabilizing for global trade. Since 1995, China has kept its rate effectively pegged to the dollar, at a low level that makes its exports ultracompetitive in world markets.

Now experts such as Nobel laureate Paul Krugman still see the renminbi as underpriced. Goldman Sachs is predicting a rise, and Wells Fargo expects that the renminbi could gain as much as 15% by the end of next year. Those would be massive tailwinds to well-positioned Chinese stocks.

Here's why the renminbi is likely to rise soon.

To maintain a fixed exchange rate, China has had to buys tens of billions of dollars every month in order to resist the pressure toward currency appreciation caused by the inundation of foreign capital into its too-cheap markets.

As if that weren't enough, China's exchange rate policy is throwing a spanner into the work of policymakers to get developed economies humming along again. As the Federal Reserve reduced interest rates to jump-start America, the dollar depreciated relative to other currencies. Since the renminbi was tied to the dollar, U.S. exports gained little to no advantage against China, while Europe suffered further. China effectively "piggybacked" American efforts.

As Krugman explains, "In the current environment, with high unemployment around the world and policy interest rates as low as they can go, this is a predatory, beggar-thy-neighbor policy."

Throughout this saga, China complains bitterly about high inflation, and laments its extensive holdings in dollars. As both Bernanke and a group of Citigroup analysts noted, currency appreciation would help tame China's inflation, helping it buy the natural resources it so desperately needs.

How now, Mao?As I hinted above, one solution to this situation is for China to allow the renminbi to appreciate relative to the dollar. That's the line taken by the Obama administration, which recently informed China that currency policy will occupy a prominent place in their economic talks.

If China were to allow its currency to appreciate, the immediate effect would be to hurt its export-reliant industries such as manufacturing. That increase in costs would slap major importers from China such as Wal-Mart (NYSE: WMT) and Ford (NYSE: F) , which source billions in products from there.

However, the currency move would help American companies that are quickly expanding Chinese operations. Starbucks (Nasdaq: SBUX) and Yum! Brands (NYSE: YUM) , with its massively popular KFC franchises in China, are looking to grow thousands of operations. But obviously, they're not pure plays on China and won't experience the full burst of the renminbi's appreciation. To find such an opportunity, it's a good idea to look at Chinese companies.

But rather than haphazardly buying Chinese stocks and hoping that American and Chinese politicians can come to an agreement, a better strategy is to find absolutely solid Chinese companies that are thriving now and will continue to thrive if and when the renminbi appreciates. Then currency gains can become the tailwind to a great investment.

Stocks such as these would be likely winners from currency appreciation:

By buying an efficient and reasonably priced company such as China Mobile, you have the opportunity to profit from an undervalued company as well as the appreciation of the renminbi. Better still, your investment gains in dollar terms even if the stock's relative valuation remains the same. That is, because currency appreciation is driving the stock up and not investors willing to pay a higher P/E, a cheap company is still cheap and you've captured a currency gain for free. Tack on the power of multiple expansion, and you can quickly see blockbuster returns.

An interesting propositionThere is plenty of noise in policy circles about China's cheap currency, but of course China is not the only place where you can use exchange rates to juice your returns. At Motley Fool Global Gains, advisors Tim Hanson and Nathan Parmelee have recommended rock-solid companies across the globe whose stocks are poised to gain from excellent fundamentals and a falling dollar. You can read all about them by clicking here to join Global Gains free for 30 days.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.

I'm no expert. But here's my so-called IMHO: my understanding is that China's policy of keeping its currency undervalued is part of what has started to lead, and could lead, to significant real inflation of prices within China. Price increases on goods used to create goods made in China, and therefore on goods made in China, already do and will impact the price of goods that importers like WMT pay (totally separate from the currency-conversion rate issue). So, WMT (we all) has/have already been subject to a significant risk of paying more in renminbe per good bought there, even if the rate of renminbi-to-dollar exchange remains constant. Thus, while delinking the renminbi (somewhat; let's not kid ourselves that China will let it fully float free within the next three years) changes the currency-conversion relationship in a way that will be negative for the WMTs of the world, it also reduces internal Chinese inflationary pressures, which is positive. Where that nets out, I'm not sure. I think WMT still ends up a loser, but less so than some think, and based upon a more complicated interplay of financial currents. Alternatively, I could have no clue what I'm talking about w/regard to the underlying macro-economics.

I tried to post this before but it didn't take. My understanding of macro-economics tells me the following: China's Under-Valuation of Yen Policy already exposes WMT (and all of us) to increased risks of real internal Chinese renminbi inflation. In other words, even if the exchange rate of renminbi-to-dollar is held constant, China's policy has started to, and will increasingly cause the amount of renminbi's one pays for the good, before currency-conversion, to rise. Thus, un-pegging it (partially; let's not kid ourselves that it will float freely anytime in the near future) reduces this risk, even while it means that the renminbi-to-dollar exchange ratio becomes less favorable for chinese exporter companies, and so for big China-to-US importers, of which WMT is perhaps the prime example. So personally, I think it's more complicated than a zero-sum game where Chinese currency appreciation purely harms the WMTs of the world. I don't know what the net impact is though, and I suspect it is still negative for the WMTs. It's just not as bad some might think.

Alternatively, I might have a completely flawed understanding of the macro-economics, and have no clue what I'm talking about.

I've read you on several posts. I think you have more understanding than most. At least you are thinking and you know you have much to learn still.Then too, who really understands Chinese government and monitary policy. I'm looking forward to chinese labor cost being in line with the rest of the world. That will probably take a few monetary changes. That may be a big dream in the foreseeable future.

It all comes down to forming an opinion from what you (think) you know. Even if you don't 'have a clue', I appreciate the opinion. It's always food for thought. Keep 'er up.

You talk as if China runs on normal capitalist rules It is in fact, a deformed workers state. As such their primary concern is keeping an expanding working class employed. That is more important than anything thus they are wary to let the yuan float up.

As for the comment by Mountain8 that he looks forward to Chinese labor costs being in line with the rest of the world---don't hold your breath on that one ...after all they have a population of 1.3 billion and 500 million of them are still peasants that want to join the step up to the working class.

If you want to bet on the renmimbi, why not buy a good China mutual fund instead of trying to figure out which individual stock to buy, which is a mug's game? There are both open end and closed end China funds that have good records. Over the last 10 years, they have been among my (and others') best investments.

The renminbi or the Chinese yuan (sign: ¥; code: CNY) is the official currency of the People's Republic of China (PRC), with the exception of Hong Kong and Macau. The Chinese yuan is normally abbreviated as ¥ or CNY. Renminbi (simplified Chinese: 人民币; traditional Chinese: 人民幣; pinyin: rénmínbì) translates as people's currency. The renminbi is issued by the People's Bank of China, the monetary authority of the PRC.

Renminbi had be puzzled too so I googled it. My only exposure to Chinese stocks is through a 5 star rated Chinese fund which has done about 9% since I bought it in August. Buying a individual Chinese stock seem risky when I don't have good sources for exactly what the market forces are doing regarding that stock.

Everything the Fool says about Chinese stocks is exciting. I agree fully that there are fortunes to be made. One problem though; we do not understand communism and they don't seem to care one bit about us. Here's proof: Rio Tinto news...

Stern Hu, the Shanghai-based head of Rio's iron ore operations in China, was detained on July 5, 2009, along with three Chinese colleagues on suspicion of stealing commercial secrets.

So, the chinese didn't like the price Rio Tinto wanted for their iron ore, thus arrested Stern Hu. That's how they do business communist style. That is why I refuse to buy chinese stocks, no matter what.

Well there's a couple China stories with a kicker. The first is the ADM and the little trickier ADM-A Cv. China imports more than 50% of their soy beans and soy products. Sort of how the US deals with the oil conundrum . Soy beans require a wet hydrology of a temperate climate. So along the US Gulf coast and in the Delmarva there are some ideal areas for growing soy beans, ADM supermarket to the world. So mChina will continue ramping up it's soy imports and consumption for poultry, livestock, and fish farming to satisfy demand for more protien rich meats and fish. ADM is also ramping up ethanol production with a new plant and a recently retrofitted one as well. Argentina just brought in a monster corn crop. The early planting data for the US shows that the rotating crops fields are mostly rotating into corn this year. In addition there is a proliferation now of drought resistant corn being planted as well in Kansas, Missouri, and Nebraska. The US is going to produce a record or near record corn crop this year. That coupled with the Argentina strong crop and higher US interest rates making the US Pe$o appreciate will make corn very cheap for US domestic consumers but more expensive to countries that want to purchase US corn crops for export overseas. With oil now in the $80 to $95 /BBL range the US government is going to continue to urge on and subsidize ethanol. By Sept the Dec corn futures should be below $3.10. Natural gas is the other ingredient and it too is holding to near $4/MM~BTU. Lower costs to produce ethanol and demand from refiners bringing up the price. The ethanol business is then the kicker.

The other is STO Statoil. You get a major integrated with many new discoveries and in a Strong hard currency. STO just raised their once annual dividend, now +4%. China is continuing to fill it's strategic Petroleum reserve. Global auto production has pushed up both oil and Palladium. With Statoil you get a nice Aluminum smelting business as a kicker. Statoil could be purchased on any pull back of more than one Day in Crude prices.

I have made excellent gains in Embraer. the Brasilian aircraft company - check their chart and read up on them. Of course, I also have excellent connections and am buying a condo at the beach in Brasil.